The text of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) is linked here.
Title III of BAPCPA is named “Discouraging Bankruptcy Abuse,” and § 321 (from said Title III) is named “Chapter 11 Cases Filed by Individuals.” Such § 321 makes the following changes to the Bankruptcy Code for individual Chapter 11 debtors:
- it includes debtor’s post-petition assets and earnings as property of the bankruptcy estate (§ 1115(a));
- it requires debtor to pay projected disposable earnings into a plan for five years (§ 1129(a)(15));
- it allows debtor to retain post-petition assets and earnings under a plan (§ 1129(b)((2)(B)(ii));
- it defers debtor’s discharge until the end of the five years plan (§ 1141(d)(5)); and
- it allows for a post-confirmation modification of debtor’s confirmed plan (§ 1127(e)).
A Question & Two Answers
Cases applying such BAPCPA changes, for individual debtors, often ask this question about the effect of such changes:
- Did BAPCPA abrogate the absolute priority rule for individual debtors in Chapter 11?
Such question leads to two different answers (see, e.g., In re Joseffy, 654 B.R. 747, 752-53 (Bankry. S.D. Fla., 2023):
- a “narrow view” says the absolute priority rule is not abrogated for any Chapter 11 debtor; but
- a “broad view” says it is abrogated for individual debtors.
A Better Question
But I suggest that’s the wrong question. A better question is this:
- Did BAPCPA codify a new value exception/corollary to the absolute priority rule for individual Chapter 11 debtors?
I’ll to explain why that is a better question.
Some History of the New Value Exception/Corollary
Back in the 1980s Farm Crisis, farmers couldn’t get a Chapter 11 plan confirmed because of the absolute priority rule. One Farm Crisis issue that made its way to the U.S. Supreme Court is this:
- Can a farmer’s pledge of future labor and management skill on the farm qualify for a new value exception/corollary to the absolute priority rule?
On that issue, the U.S. Supreme Court explains (in Northwest Bank Worthington v. Ahlers, 485 U.S. 197, 203 (1988)):
- “It is, of course, clear that there are circumstances under which stockholders may participate in a plan of reorganization of an insolvent debtor. . . ”; but
- “the stockholder’s participation must be based on a contribution in money or money’s worth.”
In Ahlers the Supreme Court declares:
- the pledge of “continuity of management” to the reorganized debtor to be “inadequate consideration” and could not possibly be deemed “money’s worth”;
- the same is true of a pledge of future labor and management skills—farmer’s promise of future services (i) is intangible, inalienable, and, in all likelihood, unenforceable, and (ii) “has no place in the asset column of the balance sheet” of the reorganized debtor;
- unlike “money or money’s worth,” a promise of future services cannot be exchanged in any market for something of value to the creditors today; and
- such a promise is not “an adequate contribution to escape the absolute priority rule” (485 U.S. at 204).
Ninth Circuit and the New Value Exception/Corollary to the Absolute Priority Rule
Courts in the Ninth Circuit have more than three decades of history applying the new value exception/corollary to the absolute priority rule. And during those decades, the U.S. Supreme Court has declined to reign them in.
–First and Recent Ninth Circuit Rulings
In 1993, the Ninth Circuit Court of Appeals declares that the new value exception/corollary to the absolute priority rule survived enactment of the Bankruptcy Code and may be used by debtors in Chapter 11 cases.[Fn. 1] It does so on these grounds:
- the new value doctrine “is not actually an exception to the absolute priority rule but is rather a corollary principle, or, more simply a description of the limitations of the rule itself” (2 F.3d at 906);
- the absolute priority rule is contained in § 1129(b)(2)(B)(ii) and bars old equity from receiving any property via a reorganization plan “on account of” its prior equitable ownership when all senior claim classes are not paid in full (id. at 908-09); and
- when old equity offers value that is (i) new, (ii) substantial, (iii) money or money’s worth, (iv) necessary for a successful reorganization, and (v) reasonably equivalent to the value or interest received, they are not receiving any property “on account of” their prior ownership interests (id.).
Three decades later (in 2023), the Ninth Circuit BAP explains the “new value exception” to the absolute priority rule like this:
- “when old equity makes a new, substantial, necessary and fair infusion of capital it may retain its interest notwithstanding the absolute priority rule.”[Fn. 2]
–U.S. Supreme Court’s Second New Value Exception/Corollary Opinion
In 1998 (between the 1993 and 2023 dates of the two Ninth Circuit opinions cited above), the U.S. Supreme Court weighs in—again, after Ahlers—on the new value exception/corollary.[Fn. 3] And it does so by taking the same non-committal position as before, saying:
- “The Seventh Circuit in this case joined the Ninth in relying on a new value corollary to the absolute priority rule to support confirmation of such plans”;
- “The Second and Fourth Circuits, by contrast, without explicitly rejecting the corollary, have disapproved plans similar to this one”; and
- “We do not decide whether the statute includes a new value corollary or exception, but hold that on any reading respondent’s proposed plan fails to satisfy the statute.”
BAPCPA’s New Value Exception/Corollary
Seven years later, Congress enacts BAPCPA with (i) its requirement that individual Chapter 11 debtors contribute projected disposable earnings for five years, and (ii) its withholding of the individual debtor’s discharge until the five years of plan payments are completed.
That looks like a codification of the Ninth Circuit’s new value exception/corollary to the absolute priority rule for individual debtors.
After all, what’s the point of establishing a five years plan requirement if creditors can veto a plan, anyway, by simply demanding enforcement of the absolute priority rule?
And remember that a primary focus of BAPCPA was to keep middle class consumers out of Chapter 7, force them into one of the reorganization chapters (i.e., either chapters 11 or 13), and make getting a discharge difficult in those reorganization chapters—but not impossible. So:
- the point of the five years plan provision in both chapters 11 and 13 and the deferred discharge in Chapter 11 for individuals was to make reorganization difficult for middle class consumers—but not impossible;
- the five years and deferred discharge provisions make no sense in 2005, except as a response to the new value exception/corollary being applied across broad swaths of these United States (e.g., in the Seventh and Ninth circuits); and
- for the bankruptcy districts that do not recognize the new value exception/corollary, getting an individual’s Chapter 11 plan confirmed is very difficult—and so,
- those five years and deferred discharge provisions are meaningless, irrelevant and immaterial; and
- they provide no form of “abuse prevention.”
A Subchapter V Illustration
More recently (in 2019), Congress created another new value exception/corollary to the absolute priority rule by enacting the Small Business Reorganization Act (aka Subchapter V) within Chapter 11.
Only this time (in 2019), it do so for all qualifying small businesses—not just for individuals. And it did so without specifically mentioning the absolute priority rule.
Conclusion
One thing Congress actually did, when it enacted BAPCPA and its five years plan payments and discharge deferral provisions, was this:
- it provided guidelines and limitations on how the new value exception/corollary for individual debtors is to be computed and applied.
What do you think?
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Footnote 1. The Ninth Circuit did so in the case of Bonner Mall Partnership v. U.S. Bancorp Mortgage Co. (In re Bonner Mall Partnership), 2 F.3d 899 (9th Cir. 1993), motion to vacate denied, 513 U.S. 18 (1994).
Footnote 2. The Ninth Circuit BAP opinion is Albaad USA, Inc. v. GPMI, Co. (In re GPMI, Co.), Case No. AZ-22-1231 (9th Cir. BAP, decided June 21, 2023).
Footnote 3. The U.S. Supreme Court’s second opinion is Bank of America National Trust and Savings Association v. 203 North LaSalle Street Partnership, 526 U.S. 434 (1999).
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